I. Field of the Invention
The present disclosure generally relates to systems and methods for performing asset valuations. More specifically, the present disclosure relates to systems and methods for determining the value and marketability of an asset or pool of assets.
II. Background Information
Generally, the value of an asset is based on various factors such as the stream(s) of expected cash flows associated with the asset. Accordingly, assets can be valued by estimating the cash flow stream by: (1) determining the expected cash flow for each time period; (2) determining the risk associated with receiving each cash flow; and (3) discounting each cash flow by an expected rate of return, which may be based on the risk of receiving the cash flow. To obtain the present value of an asset, all of the discounted cash flows may be summed together.
When purchasing an asset such as real property the purchaser often contracts for a mortgage on the asset and agrees to make periodic payments toward the mortgage. Often the time period for making each periodic payment is monthly. If the property is sold before the mortgage has been paid in full, which is not unusual, the balance of the mortgage may become the last payment. Thus, for real property, the expected cash flows to the lender may comprise either monthly payments until the mortgage is paid in full or monthly payments plus a final payment. For the lender to value real property, the risk associated with receiving each of the periodic payments and in some cases, the risk of receiving the remaining loan balance if the property is liquidated before the mortgage has been paid in full, must be determined. In such cases, the valuation may be derived from analyzing each of the monthly payments and analyzing the final payment.
A challenge with producing a valuation of an asset is determining the risk associated with receiving the expected cash flow. To determine risk, most valuation techniques use either a rudimentary approximation or a subjective assignment of risk in the discount rate and the expected cash flow. Understandably, failing to accurately account for a cause of risk can lead to undervaluation or overvaluation errors. These valuation errors can be significant for financial institutions which conduct transactions where multiple assets are combined to form pools that are then bought and sold.
One historical method of valuation is an appraisal, which subjectively compares a set of characteristics of a subject asset to the same set of characteristics of a standard, with the standard being a comparable asset. The term “subject asset” typically refers to the asset under investigation for which an appraised value is sought. An important consideration for appraising the value of a subject asset is the development of the standard. One method to form the standard has been to select a set of comparable assets, whose sales prices are known. Each asset in the set of comparable assets is as similar as possible to the subject asset. The term “comparable asset” refers to assets, other than the subject asset, that are used to form the standard and assist in appraising the subject asset. In the case of real property, the comparable assets typically include properties that are physically located near the subject asset.
A common use for an appraisal is in connection with the sale of a property. The seller will typically contract with an appraiser to conduct an appraisal, and the appraisal becomes a substantial factor in setting the asking price. Similarly, the prospective buyer may also contract an appraiser to provide an appraisal for the property. A more commonplace use of an appraisal is for mortgage lending purposes imposed by the lender so that the lender can have an objective opinion on the value of the property. In the most common scenario, the lender will initiate the process and procure an appraisal of the subject property. Depending on the outcome of the appraisal, negotiations may take place between the buyer and seller to determine the price that the asset sells for.
Problems arise, however, when the appraisals do not accurately capture the actual value of the property. In this case, the seller may unjustifiably demand a price for the property that is greater than the actual value of the property. Buyers and lenders, also relying on appraisals, may be led to believe that the asking price is justified and pay/lend the negotiated price based on incorrect appraisals. Thus, the borrower can become bound to a loan, the amount of which, is greater than the actual value of the property.
With these properties, there is a greater risk of default because the borrower may not be able to pay the unjustified, high mortgage payments. Generally, the term “default” is used to describe the situation where payments on a loan remain unpaid for a predetermined period of time. Similarly, if a default does occur on these properties, the severity may be greater than what would have been expected with an accurate appraisal. Severity is a term used to describe the loss incurred should a loan default, including lost principal and interest as well as costs incurred during the default process.
In addition, when the buyer, now the owner of the property, wants to sell the property, he/she will be more likely to attempt to sell the property for more than the price that informed purchasers would be willing to pay. In this situation it may take longer than expected to sell the property. Alternatively, the owner may be forced to lower the price of the property in order to make the sale. If a balance remains on the mortgage, both the buyer and the lender are exposed to the risk of not being able to sell the property for an amount that is sufficient to cover the difference between the price paid by the owner and the price that the asset can be sold for in the market. In the alternative, if there is no outstanding balance, the owner and/or lender may take a loss on the sale.
One significant factor of risk that has often been difficult to quantify in an appraisal process is the risk associated with marketability of a subject asset. Broadly speaking, marketability reflects the asset's liquidity. Clearly, the ability to liquidate an asset will influence how much the asset can be sold for, in part because individual purchasers and investors do not want to purchase assets that cannot be readily resold at a later time. If a marketability issue exists, the price of the asset may have to be lowered so that it can be sold. While appraisers can observe marketability and may include a discussion of it in an appraisal report, they may have difficulty in quantifying marketability, and may not relate marketability to risk.
Historical data has shown that an asset's marketability significantly impacts the risk associated with receiving the cash flow. This is especially the case when markets face a down-turn. And failing to account for a cause of risk often distorts the valuation of a subject asset.
Appraisals have historically been conducted by qualified professionals known as appraisers. A common component of the appraisal process is for the appraiser to physically inspect the subject asset. While appraisers try to make appraisals as quantitative as possible, errors in valuations often occur. For example, when appraising a subject asset, the appraiser may evaluate characteristics common to the subject asset and the comparable asset. The appraiser compares the characteristics of the subject asset to the corresponding characteristics of one or more comparable assets and adjusts the sales price of the comparable asset to reflect dissimilarities between the subject asset's characteristics and those of the comparable asset. The adjusted prices for the comparable assets are then used to value the subject asset. A subject asset with characteristics similar to those of comparable assets will most likely have a value similar to that of the comparable assets. While on its face this method of comparing characteristics seems quantitative, appraisers subjectively select property characteristics, comparable assets, and give certain characteristics greater importance in one appraisal than they do in another. One appraiser may choose characteristics or comparable assets that are significantly different from those chosen by another appraiser. In addition, some appraisers emphasize the effects on value of certain characteristics more than others do.
For example, when developing the set of comparable assets, an appraiser typically chooses comparable assets physically located near the subject asset. Because the nearby assets often are not identical or even similar to the subject asset, choosing the set becomes subjective. Additionally, the appraiser may disregard nearby assets because they are not typical and the appraiser will enlarge the area around the subject asset in which they choose comparable assets in order to create a meaningful set.
One method of standardizing appraisals of real estate property has been the Sales Comparison Approach (SCA). Using this technique, prices paid in actual market transactions and current listings of similar assets are used to estimate the value of the subject asset. In the SCA, the actual sales prices of comparable assets adjusted for market conditions and differences in characteristics operate to approximate the value of the subject asset. Current listings of comparable assets are used to adjust the value of the comparable assets in both advancing and declining markets.
An inherent flaw of this approach is that the selection of the characteristics and the selection of comparable assets are subjective. Further, it may be extremely time consuming and inefficient for an appraiser to inspect many potential comparable assets and to make an explicit determination as to how similar each potential comparable asset is to the subject asset. This is especially true when multiple comparable assets or multiple characteristics are used.
In an attempt to standardize their work, appraisers have begun using computers to facilitate the appraisal of a subject asset. One such computer-based system is referred to as the Artificial Intelligence Model (AI), an example of which is disclosed in U.S. Pat. No. 5,361,201 to Jost et al. The AI system of Jost et al. determines medians, averages, and variances for various property characteristics, such as sales price, square footage, and number of bedrooms. With these variances computed, the AI system uses neural networking for “training” the system and after the system is trained, attempts to predict the future sale price of a subject property. This system, however, does not quantify risk let alone consider the impact of marketability on risk when predicting the future price of a subject property. As a result, AI systems such as Jost et al. may provide inaccurate appraisals, particularly for those properties with marketability problems.
Using approaches such as the traditional appraisal process or AI systems, the accuracy of the valuation may be susceptible to error as these approaches can ignore or misjudge key risk factors, such as marketability.
Automated tools, such as AI systems, typically make broad assumptions about the risk associated with a subject asset, either that the subject asset is conforming, non-conforming, or extremely non-conforming. Additionally, these tools may incorrectly assume that the subject asset has the same risk that it had the last time it was sold. Past valuation tools that compare characteristics of a subject asset to characteristics of comparable assets have not been capable of quantifying or accounting for marketability.
Further, appraisals can be costly and time consuming, especially when multiple assets are involved. A typical appraisal of a single asset can cost hundreds of dollars and take weeks to schedule and complete. This can be a substantial inconvenience to the individual wanting to purchase, sell or refinance a home. Even worse, however, an investor wanting to value a pool with thousands of assets may be precluded, as a practical matter, from conducting appraisals of so many assets due to time and cost constraints.
Therefore, there is an unfulfilled need to have a quantitative measure of value, ex ante, when purchasing a particular asset or making or purchasing a loan secured by a particular asset. What is needed is a method and system of providing a quantitative measure of an asset's marketability so as to accurately assess an asset's value, or the value of a pool of assets.